Posted on: Monday, July 26, 2004

Fed's forecast called too optimistic

By Sue Kirchhoff
USA Today

WASHINGTON — The Federal Reserve expects above-average growth, declining unemployment and low inflation through the end of the year and into 2005 — an outlook some economists consider too rosy.

"It's doable on the growth side ... they are too optimistic on the inflation front," said Brian Wesbury of Griffin Kubik Stephens and Thompson, a Chicago investment-banking firm. "They sort of have us obtaining nirvana again like the 1990s boom."

In its semiannual economic report to Congress last week, the Fed predicted growth in 2004 to average 4.5 percent to 4.75 percent. The core inflation rate, which doesn't include food

and energy prices, will top out at 1.75 percent to 2 percent, and unemployment — now 5.6 percent — will average 5.25 percent to 5.5 percent in the fourth quarter, falling to as low as 5 percent at the end of 2005.

The economy grew at a 3.9 percent annual rate in the first three months of the year. The Commerce Department will announce the second-quarter growth rate Friday.

Given that retail sales declined in June, industrial production slowed and businesses created fewer jobs than predicted, some forecasters expect strong but not exceptional growth from the April-June period.

Bear Stearns is estimating growth of 4 percent or lower in the first half of the year, implying the economy would have to expand at a 5 percent or better annual pace through the end of the year to meet the Fed's projection.

Several analysts call that possible, expecting a ramp-up in business spending, continued strong hiring, a leveling off or decline in oil prices and stronger expansion abroad, helping U.S. exports. But some are skeptical that robust growth and low inflation will continue to be compatible.

Wesbury and others argue that even though the Fed has started to raise short-term interest rates — pushing them to 1.25 percent from 1 percent in late June — monetary policy is still too easy. He expects core inflation to hit 3 percent by the end of 2004 and 3.5 percent to 4 percent in 2005 unless the Fed gets tougher.

"That (Fed forecast) would be an amazing outcome if we could do it. Anything short of an amazing outcome, they're going to have to alter their forecast," said Jim Paulsen, chief investment strategist at Wells Capital Management.

He is concerned that the Fed, which has moved to a policy of open communication to prepare the markets for rate rises, could end up having to make a surprise move if its forecast is wrong — the very thing it doesn't want to do.

But others say forecasts are merely that, forecasts. Fed Chairman Alan Greenspan and other central bank officials have made it abundantly clear they will act on actual data — either raising rates more slowly or speeding up increases — depending on how quickly inflation builds.

Federal Reserve Bank of Chicago President Michael Moskow said Friday the Fed will be "vigilant" in tracking prices, adding that higher prices for a number of goods have been offset by price declines elsewhere.

"The (Fed) growth numbers are a little higher than mine. ... I'm not sure it matters that much," said David Wyss, chief economist at Standard & Poor's.

"The Fed will adjust if the economy doesn't perform. This isn't like a budget process, where you budget a year in advance. They only have to budget for the next six weeks," until they meet on rates, Wyss said.